This invention relates to a data processing method for monitoring and controlling a loan that is used for the purpose of funding a defined contribution pension plan. This loan involves a financial transaction in which an asset is appreciated by lending money to contribute to the asset while using, directly or indirectly, the asset as collateral for the loan.
Many corporate employers have employee savings plans that include provisions for matching employee contributions, such as plans established in accordance with section 401(k) of the Internal Revenue Code. Presently, up to twenty percent of eligible employees do not take advantage of this benefit. Enabling these employees to borrow in order to fund their unused or under-utilized benefits provides both the employee and the lender with high returns because of the matching contributions by the employer. There is currently no financial product that adds incentive to participate in such savings plans.
In the coming years, individuals will be forced to take more responsibility for meeting the financial needs associated with retirement. The rapidly declining ratio of workers to retirees will force cutbacks in Social Security. The traditional defined benefit pension plan is also in decline due to escalating costs. Defined contribution plans, such as the 401(k), have emerged as the preferred retirement vehicle for corporate employees. This demand has resulted in a rapid increase in both the number of plans and participants.
Loans using 401(k) assets as collateral are not uncommon. Approximately seventy percent of all 401(k) plans allow installment loans. However, such loans are strictly regulated by the U.S. government, which must approve any new type of loan using pension assets as collateral. The approval process can be daunting and success is not assured. Thus, there are relatively few types of loans.
There are two types of installment loans currently available. The most common is a general purpose loan that has a maximum term of five years. There is also a residential loan that is restricted to the purchase of a primary residence and has no legal limit on term. Under the current law, one may borrow up to one-half the asset value in the defined contribution plan (up to a maximum of $50,000), with loan payments being made at least quarterly. Typically, the interest on the loan is paid back into the account of the borrower. Administrative fees are permitted.
In June 1995, the U.S. Department of Labor approved a credit card based upon 401(k) assets. This product is described in U.S. Pat. No. 5,206,803 (Vitagliano et al.). The card has a credit limit of $10,000and the lender profits from a portion of the interest and from loan administration fees. The loan principal is entirely funded through the borrower's existing 401(k) account and a portion of the interest is returned to the borrower. This product is indicative of the maturing financial products available to defined contribution pension plans.
Most 401(k) plans allocate employee contributions into a pre-tax account. Many plans, more typically in large corporations, include the alternative of allocating contributions into an after-tax account. The assets in an after-tax account grow tax-deferred, with only the original contribution being taxed. Withdrawals from a pre-tax account are subject to stringent hardship regulations, with the exception of termination of employment. However, funds in an after-tax account may be withdrawn at any time. Some employers allocate their matching contributions to an after-tax account irrespective of the account used for an employee's contribution. The matching contribution is still tax deferred but the use of an after-tax account allows easier access to the funds. On the down side, some employers do not provide matching of after-tax contributions.
A key difference between the pre-tax and after-tax options is the effect on an employee's take-home pay. An after-tax contribution includes both the 401(k) investment and the taxes on those funds. In contrast, the only component of a pre-tax contribution is the investment capital; all taxes are deferred. Hence, the absence of taxes on pre-tax contributions reduces the employee's taxable income relative to funding the plan with after-tax monies. This translates into a smaller decrease in net income for pre-tax contributions versus after-tax contributions of the same contribution amount.
At present, all financial arrangements based on a 401(k) plan seek to use the assets of the plan without loss of tax status. None are directed to increasing the value of an asset. A line of credit for building a house is, in a sense, a loan for increasing the value of an asset. The house under construction is collateral for the loan and payments by the lender are made as necessary as various stages of construction are completed. When the house is completed, the loaned amount becomes the principal in a conventional mortgage having an amortization schedule of fixed payments.
There are many kinds of loans tailored to particular circumstances but, in general, most loans include a single, initial payment by the lender and periodic payments of a fixed amount by the borrower. Credit cards and other forms of lines of credit are somewhat more fluid but all require periodic repayment.
The cash flows of a defined contribution pension plan are typically a series of payments into the account and a single lump sum disbursement to the employee upon termination. This lump sum disbursement is often rolled over into an Individual Retirement Arrangement (IRA) account or into another employer's defined contribution plan. Hence a method that duplicates these cash flows would be ideal for funding a 401(k) plan.
Financial products that eliminate periodic repayment schedules are not uncommon. A "bullet" loan is one example of an arrangement wherein a single payment is due at the end of the loan period. The loan typically carries a very high interest rate, several points over the interest rate on a treasury bond. Similar to the bullet loan, a zero coupon bond is a common type of financial instrument that also returns only a single cash flow upon reaching term. Theoretically, a series of bullet loans or zero coupon bonds could be used to duplicate the cash flows needed to fund a pension. However, there currently exists no data processing system designed to ease the associated administrative burden.
A "reverse mortgage" provides periodic payments to the borrower and requires a single payment from the borrower at the end of the loan; e.g., as described in U.S. Pat. No. 5,083,270 (Gross et al.). The interest rate may be fixed or variable. Such loans liquidate an asset without actually selling the asset. The loan is secured by the asset and is repaid at the death of the borrower by the estate. Applying this type of loan to the funding of a pension requires a level of prescience that few lenders possess due to the variable term and adjustable disbursements. The loan also requires that the borrower be the average person described in a mortality table. The result is that assets are evaluated very conservatively, which limits the size of the loan. Thus, a reverse mortgage requires assets of significant value and is unlikely to be available to the average person.
Another type of loan is one in which the principal is not amortized, i.e., only interest payments are made. Unlike a temporary accommodation by a lender during times of financial distress, this loan is intended from its inception not to amortize principal. An arrangement known as the Home Owner's Preferred Equity (HOPE) account is such a loan. The HOPE account is described in U.S. Pat. No. 4,953,085 (Atkins) as allowing homeowners to reduce their mortgage payments by the amount attributable to principal and to apply that amount to other investments. A homeowner continues to pay interest and other charges but does not amortize the principal. This account allows the amount attributable to principal to be used to fund a pension or other investment, without requiring any immediate repayment.
A conventional mortgage requires payment of a fixed amount that is divided between principal and interest. Initially, the amount of interest is relatively high and the remainder, applied to principal, is relatively small. Near the end of the mortgage, the relationship is reversed. On average, the turnover for a home mortgage is less than four years and the principal is reduced very little. Thus, a HOPE account is not likely to provide sufficient resources for the average homeowner to fund a defined contribution pension.
Thus, at present, attempts at providing financial security, such as a 401(k) plan, are being thwarted by financial schemes that exploit the present value of an asset at the expense of the future value of that asset, making the term "financial planning" somewhat of an oxymoron. There is a need in the art to encourage savings and a 401(k) plan is an attractive vehicle for that purpose.
In view of the foregoing, it is therefore an object of the invention to provide a method for encouraging savings by persons of modest means.
Another object of the invention is to provide a method for managing accounts in which a borrower makes periodic payments from a loan into an account and the loan is not paid until the account is closed.
A further object of the invention is to provide a method for managing an account in parallel with a 401(k) plan wherein loaned amounts are applied to the plan.